Alex Cotoia, Regulatory Manager and Compliance Consultant, rejoins us for a blog post of the SEC’s adoption of foreign issuer disclosure rules. Alex can be reached at [email protected].

On December 3, 2021, the U.S. Securities and Exchange Commission (“SEC”) announced the adoption of a final rule that fully implements the requirements of the Holding Foreign Companies Accountable Act (“HFCAA”) enacted by the Congress and signed by former President Donald J. Trump into law in December 2020.

The HFCAA—passed unanimously in the Senate and by voice vote in the House of Representatives in waning days of the 116^th Congress—targets certain domestic and foreign issuers of publicly traded securities that utilize registered public accounting firms with branches or offices in a foreign jurisdiction that does not permit oversight by the Public Companies Accounting Oversight Board (“PCAOB”). Pursuant to the HFCAA, where a “covered issuer” utilizes such an accounting firm to prepare its required audit report, the SEC is required to identify that issuer and the issuer is subsequently required to provide documentation establishing—to the SEC’s satisfaction—that the issuer itself is neither owned nor controlled by a governmental entity in the foreign jurisdiction.

To the extent the issuer is a “foreign issuer” within the meaning of Exchange Act Rule 3b-4, then more robust disclosures are required. Specifically, the HFCAA mandates that such foreign issuers provide, within the context of their annual report filing: (1) information that identifies the PCAOB-identified firm that has prepared the audit report; (2) the percentage of the shares of the issuer owned by governmental entities in the foreign jurisdiction where the issuer is registered or organized; (3) whether governmental entities in the foreign jurisdiction with respect to the registered public accounting firm have a “controlling financial interest” with respect to the issuer; (4) the names of any Chinese Communist Party (“CCP”) officials who are members of the board of directors of the issuer or any affiliated operating entity; and (5) whether the articles of incorporation or any other organizing document of the issuer contains any charter of the CCP or the text of any such charter.

The final rule adopted by the SEC thus revises Forms 20-F, 40-F, 10-K and N-CSR to implement the requirements of the HFCAA and provide for the legislatively mandated disclosures. As a result of the implementation of the final rule, the SEC may now require any covered issuer—domestic or foreign—to submit through EDGAR, on or before the due date of the relevant report, documentation establishing that the issuer is neither owned nor controlled by a governmental entity in the foreign jurisdiction of the PCAOB-identified registered public accounting firm. In adopting the rule, however, the SEC declined to delineate specific documentation requirements, preferring instead that the issuer itself “make a determination of what documentation meets the requirements for their particular company.” As such, affected issuers retain considerable discretion to furnish the SEC with whatever documentation they deem most suitable to meet the HFCAA’s requirements. While this rule may ultimately evolve into a standardized submission over time, the SEC took care to note that the immediate imposition of such a requirement would likely increase compliance costs and prevent the public from accessing additional relevant information.

As it pertains to foreign issuers specifically, it is notable the final rule adopted by the SEC makes it more difficult for entities utilizing a variable interest entity (“VIE”) structure to conceal foreign governmental ownership. In response to concerns raised during the period for public comment, the final rule explicitly requires such foreign issuers to look through a VIE or any other structure that results in additional foreign entities being consolidated—and thus potentially overlooked—in the issuer’s financial statements. Indeed, the amended forms now require such foreign issuers to provide the disclosures outlined above for themselves and all of their consolidated foreign operating entities.

The final rule takes effect thirty (30) days following official publication in the Federal Register. As originally introduced in the Senate by John Kennedy (R-Louisiana), the legislative purpose behind the HCFAA was to provide additional assurances to investors worldwide that audit reports of foreign issuers choosing to list their securities on U.S. exchanges were credible by subjecting them to the scrutiny of PCAOB. The adoption of the final rule by the SEC faithfully executes this intent and provides greater investor transparency into the sometimes-obscure machinations behind real ownership and control over foreign entities.